Why don't all firms issue commercial paper rather than borrow from banks.
Not all firms issue commercial paper instead of borrowing from banks for several reasons. Let's break down the factors that influence this decision:
1. Accessibility and Eligibility: Commercial paper is typically available to large, financially sound corporations with strong credit ratings. Smaller firms or those with lower creditworthiness may not be eligible or have limited access to the commercial paper market. Banks, on the other hand, may be more willing to lend to a wider range of borrowers, including smaller firms or those with less favorable credit profiles.
2. Cost and Flexibility: The cost of issuing commercial paper can vary depending on market conditions and the creditworthiness of the issuing firm. While commercial paper rates can be lower compared to borrowing from a bank, they are subject to fluctuations in the market. Banks provide more stable and predictable interest rates, making it easier for firms to plan their financial commitments. Additionally, bank loans often come with more flexible repayment terms, including the option to negotiate covenants and adjust borrowing amounts to meet changing business needs.
3. Investor Base: Commercial paper issuance relies on attracting short-term investors who want a place to deploy their funds for a brief period. While there is a significant pool of investors in the commercial paper market, firms need to build relationships and establish credibility with these investors to ensure continuous access to funding. Borrowing from banks allows firms to tap into a different source of funding, relying on a long-term relationship with the bank instead.
4. Market Conditions: The availability and cost of commercial paper can be influenced by market conditions and economic factors. In times of market instability or credit tightening, the commercial paper market may become less favorable, making borrowing from banks a safer and more reliable option.
In summary, while commercial paper can be a cost-effective and accessible funding source for certain firms, borrowing from banks offers advantages such as wider eligibility, stability, flexibility, and consistent access to funding. The decision ultimately depends on the specific needs and characteristics of each firm.